Introduction to the Stock Market
A stock represents a part ownership of a company. If a business has 100 shares of stock, and we own 10 shares, then we legally own 10% of the entire business. The stock market is where people go to trade and invest in stocks of different companies. If a company is worth $100 and there are 100 shares, then each share of the company is worth $1. If the company does well and make a lot of money which it then uses to grow and become bigger, investors may soon bid up the price of each share to $2. Because there are still 100 outstanding shares, the company is now worth $200. The reason a company’s stock price goes up and down is because shareholder’s perception of what the company is worth in the future changes all the time. If you own a share in a company then you have claim to a part of that company’s assets and future profits :0)
How the Stock Market Works
A coffee company just became listed on the stock market. They made $1 million in profit last year from their 100 different store locations. They tell investors they plan to use the profit to open up 5 new stores this year and grow their sales even more 🙂 Investors can now own a piece of this coffee business. But how much is the company worth? The stock market works like a big auction where bidders and askers must agree on the same price. The company basically can run itself and is expected to be increasingly more profitable over time. If we paid $1 million to buy the entire company today we would expect the company to generate at least $1 million for us in one year’s time because that’s how much it made last year. That’s a 100% return on our investment. Sounds like a really awesome deal 🙂 Unfortunately when a company is publicly traded on the stock market it can literally be bought by anyone else. So other people will try to outbid us and offer $2 million to buy the company. With a $1 million annual profit these other buyers can expect to make a 50% return on their investment every year. They would make back their initial investment in just 2 years. Still a very good deal, and of course the company will sell their stocks to the highest bidder. But what’s the maximum limit someone will pay for this company? Well probably no one would be willing to pay $100 million to buy the business, because that would only generate 1% return. There are less risky alternatives like government bonds and GICs that pay a higher return than 1% and is almost guaranteed to give you back your full principle, whereas owning a company means you lose all your investment if the business fails in the future. So this coffee business is likely worth somewhere between $1 million and $100 million. And the exact value is always what the buyers and sellers are willing to settle on at any given time. Owners of the company will always want to try and sell it for more, but buyers will always want to pay less. It’s a simple market driven by supply and demand. Hypothetically let’s say the price settles at $15 million. This means the lowest a seller thinks the company is worth is $15 million today. And the highest amount someone looking to buy will pay is also $15 million which means the buyer is looking to make about 6.7% return on investment which he feels is a good return for the risk he’s taking. But most people don’t have $15 million. That’s why the company has decided to divide its ownership into a million shares. Since the market has decided the company is worth $15 million and there are one million outstanding shares, we can say the company is trading at $15 per share. If the company surprises everyone next quarter and makes a larger profit than analysts were expecting then buyers could get really excited and decide the company’s total value (market capitalization) should actually be worth $16 million. So they start bidding higher and the stock is now trading at $16 per share because there are still one million shares that make up the business. But if the business fails to deliver or if investors feel nervous about the economy then the stock price could drop down to $14 if there are a lot of sellers but not many buyers. This is how stock prices are determined, and why they fluctuate all the time.
How to buy stocks
The first step is to open a discount brokerage account. The easiest way is to walk into your local Bank branch with 2 pieces of ID (eg: your driver’s license and a credit card,) and ask to speak with a representative to help you open up an investment account. Once you are sitting in a room with the representative tell him or her that you’d like to open up a self directed brokerage account. They will know what to do 🙂 This process is the same at all major banks. You will need to remember (or write down) 3 important pieces of information when creating your new account with the bank representative. 1) Your user ID 2) Your log in password. and 3) Your trading password, which you will only use when you actually buy or sell a stock. Once they set you up you will have access to your new account online. Alternative to traditional banks you may also go with alternative discount brokerage firms such as Questrade or Interative Brokers, for example.
Checking your online brokerage account is similar to doing online banking. Simply log in to their site on your home computer using your user ID and log in password. I suggest minimum stock investment should be no less than $1,000 to begin.
Once you have your account set up, you can begin buying stocks. Using TD’s web interface below we can buy some shares of BCE Inc, the parent company of Bell Canada. Most of these boxes are self explanatory. The Action: is to “Buy” 100 Quantity of the company “BCE.” We can either choose to buy it at whatever the “Market” price is, or set a “Limit Price” for ourselves which means if the stock price moves higher than this amount we’re not going to buy it anymore. We can also extend the expiration of this order but it’s usually not necessary.
The next step is a summary of our stock order. Since the price of BCE is trading at $47.47 per share, and we want to buy 100 shares, our total principle value is $4,747. Enter the trading password and the order process is complete.
Other brokerage firms should have a similar interface. Selling a company works the same way. Just choose “Sell” instead of buy. And for “Limit Price” it would be for the minimum amount you’re willing to sell at, instead of the maximum you’re willing to buy at.
There also indirect ways of buying stocks. Such as through mutual funds.
My Personal Experience with Stock Investing
The first stocks I ever bought was in my RRSP when I purchased some Rogers Communication, Enbridge Inc, and RioCan REIT back in 2009. My portfolio contains about 60% Canadian stocks, 30% US stocks, and 10% miscellaneous and international stocks. I like to invest in companies that have a history of growing their dividends. I also like company with strong brands because they tend to do relatively well in both good and bad economic times. It’s hard for me to keep track of my stock returns overall because I’m always adding new positions to my portfolio so my book value is constantly increasing every year.
Most companies I like to buy are medium to large cap dividend growth companies. For example I like pretty much all the companies on the S&P/TSX 60, which is an index of 60 large companies on the Toronto Stock Exchange. These include well known names like Bank of Nova Scotia, Enbridge Inc, Fortis, Saputo Inc, Tim Hortons, etc. Most of which distributes dividends back to shareholders. It’s easy to Google the entire list of 60 names, but on average the TSX 60 companies have a dividend yield of 3 to 4 percent. I try to keep my portfolio income in the same range. With dividend stocks I’m not concerned too much about their share price. How much dividend income they generate is more important to me because I want to eventually live off the passive income some day. During the last recessions in 2008 a lot of these stocks in the TSX 60 lost value, but almost all of them continued to distribute dividends without cutting their distributions. In fact, many like Enbridge even increased their dividends. At the moment I make about $5,100 dividend income per year on a stock portfolio of roughly $150,000, or 3.4%. Not a great annual return, but it’s recession proof and better than just keeping my money in a bank account 🙂